MMRCDISCUSSION PAPER SERIES
No. 559

How MNEs deal with bribe requests from local government:
The role of local sourcing and new analytical method toestimate its causal effect on subsidiary performance
Shuta TSUCHIYA
The university of Tokyo
Kiyohiro OKI
The university of Tokyo
May 2023

東京大学ものづくり経営研究センター
Manufacturing Management Research Center (MMRC)
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How MNEs deal with bribe requests from local government:
The role of local sourcing and new analytical method to estimate its causal effect on subsidiary
performance

Shuta TSUCHIYA
The university of Tokyo
tuchytuchy2000@g.ecc.u-tokyo.ac.jp

Kiyohiro OKI
The university of Tokyo

okik@e.u-tokyo.ac.jp

Abstract
When a multinational enterprise’s subsidiary (MNEs) faces bribe requests from local government officials,
MNEs find themselves often caught in a dilemma with home country values. While some qualitative studies findthat MNEs build legitimacy against unofficial pressure from government officials, no qualitative study analyzes
this phenomenon. Therefore, existing studies have not provided a sufficient empirical basis for whether unofficial
pressure affects MNEs' legitimacy-building activity. To fill this research gap, our study analyzes the relationshipbetween bribe requests, which is one of the popular government pressures, and local sourcing, which is one of
the MNEs’ legitimacy-building activities by showing their contribution to local development. As a result, wefind MNEs increase their local sourcing when receiving bribe requests. Furthermore, this study tests the validityof bribe requests from government officials as an instrumental variable to understand the causal effect of local
sourcing on a subsidiary’s performance. While existing studies have clarified the relationship between local
sourcing and subsidiary performance, they often face problems in analyzing the causal effect. This study
estimates the causal effect between them by using bribe requests from government officials as an instrumental
variable and confirms a positive causal effect between them.

Keywords: legitimacy, MNEs, bribe, local sourcing, subsidiary performance2

1

Introduction

Since local stakeholders tend to consider multinational enterprises (MNEs) with different value systems
would be harmful to the local community, stakeholders exert various pressures on the MNEs to behave ina manner consistent with local values. This pressure is called institutional pressure (Kostova, 1999; Xu &Shenkar,2002). To overcome institutional pressure, MNEs need to show the adaptation for different value
systems of the host country by appealing for their contribution to the local economy (Gao et al.,2017;
Hillman & Wan,2005), such as doing donations and building public infrastructures (Stevens & NewenhamKahindi, 2021), and local sourcing (Charpin, Powell, & Roth, 2021; Oki & Kawai, 2022; Wu & Jia,2018).
We call these activities legitimacy-building activities.
Despite the effectiveness of legitimacy-building activities, it is controversial whether MNEs takelegitimacy-building activities against institutional pressure from the local government. While somequantitative studies find that pressure from the local government has no significant influence on social
responsibility (Park & Ghauri, 2015; Reimann et al.,2012), a recent qualitative study (Stevens &Newenham-Kahindi, 2021) states that government and business have unofficial connections and MNEs
build legitimacy from unofficial pressure from local government. According to Stevens and NewenhamKahindi (2021), when MNEs are asked to pay a bribe, instead of paying the bribe, MNEs try to build their
popular acceptance and strengthen their bargaining power to reduce pressures to engage in corruption.
However, there is no quantitative study that investigates the relationship between unofficial pressure fromgovernment officials and legitimacy-building activities. Therefore, existing studies have not provided asufficient empirical basis for whether unofficial pressure affects MNEs' legitimacy-building activity. To fillthis research gap, our study analyzes legitimacy-building activities against unofficial pressure from thegovernment. As a legitimacy-building activity, we focus on local sourcing, by which MNEs show theircontribution to the development of the local economy (Charpin, Powell, & Roth, 2021; Oki & Kawai, 2022;
Wu & Jia,2018). Also, as an unofficial pressure from the government, we use the bribe request fromgovernment officials.
Furthermore, this study shows the validity of bribe requests from government officials as an instrumental
variable to understand the causal effect of local sourcing on a subsidiary’s performance. While existing studies
have clarified the relationship between local sourcing and performance, they often face problems in analyzing3the causal effect. This study estimates the causal effect between them by using bribe requests from government
officials as an instrumental variable and confirms a positive causal effect between them.
We use 231 to 384 firm-level data for MNEs that have expanded into the former Soviet Union countries
since 1993. This context provides an ideal setting for this research. First, the difference in policies among
countries was smaller than in other regions. Second, since many multinational companies moved into theregion during this period, it is possible to compare a relatively large sample of firms. Third, due to thepolitical disarray, bribe request was prevalent in this area and age.
Our paper has two contributions. First, we show that MNEs build legitimacy against unofficial pressure
from governments. While existing studies have not provided a sufficient empirical basis for whether
unofficial pressure affects MNEs' legitimacy-building activity, this paper shows that subsidiaries that arerequested to pay bribes have higher local sourcing rates than others. Second, this study reveals that theexogenous variable of bribe requests is useful as an instrumental variable of local sourcing. In analyzing
the relationship between legitimacy-building activities and corporate performance, seeking causal
relationships has been important (Lahouel et al., 2019) but few studies estimate the causal effect. This
provides important implications for future research on the causal relationship between local sourcing andperformance.

2

Theory and hypothesis

2.1

Pressure from local government and legitimacy-building activities

While some quantitative studies (Park & Ghauri, 2015; Reimann et al., 2012) show that there is no
significant relationship between pressure from the government and the legitimacy building of MNEs, recent
qualitative studies (Elg et al., 2017; Salmi & Heikkil¨a, 2015; Stevens & Newenham-Kahindi, 2021) findthat unofficial engagement has an influence of building legitimacy activities of MNEs. Stevens andNewenham-Kahindi (2021) show that when MNEs receive unofficial demands from local governments,
apart from accepting or rejecting them, they take steps to increase their voice by building legitimacy. Salmi
and Heikkil¨a (2015) research the relationship between MNEs and government officials in Russia and findsthat MNEs exchange information and engage in legitimacy-building with government officials through avariety of formal and informal channels. This behavior is also confirmed by Elg et al. (2017), which states

4that to control the uncertainty created by government involvement in business, and to show that they arecontributing to society, companies engage in legitimacy-building activities.
This inconsistency of quantitative studies and qualitative studies results from the no attention ofqualitative studies to the unofficial pressure from the government. This study investigates the relationshipbetween unofficial pressure and the legitimacy-building behavior of MNEs. To examines whether MNEs
build legitimacy in response to unofficial government pressure, we use two key indicators. First, as ameasure of pressure from the local government, we use the bribe request from government officials. This
indicator not only represents the unofficial pressure from the government but has a relationship withlegitimacy-building activities. Stevens and Newenham-Kahindi (2021) prove that “as a response to thebribe request, activities such as infrastructure investments, knowledge transfer, or high-profile summits are
deployed as alternatives to bribery.” (Stevens & Newenham-Kahindi, 2021, p287). Second, as a Legitimacy
building activity, we focus on the local sourcing rate. By enhancing local sourcing, MNEs can show theircontribution to the development of the local economy (Charpin, Powell, & Roth, 2021; Oki & Kawai, 2022;
Wu & Jia,2018). Therefore, we consider local sourcing as a means of legitimacy-building.
Assuming the results of existing studies (Charpin, Powell, & Roth, 2021; Oki & Kawai, 2022; Wu &Jia,2018), the bribe requests from government officials should enhance the local sourcing rate. Therefore,
we make the following hypotheses.

Hypothesis 1 : After receiving bribe requests from government officials, MNEs increase local sourcing rate.

2.2

Effectiveness of bribe requests from local government officials as an instrumental variable

Legitimacy-building activities are a means to enhance corporate performance (Young & Makhija, 2014).
Therefore, if it turns out that MNEs take legitimacy-building activities in response to bribe demands, it isnecessary to investigate the relationship between local sourcing and performance. At this point, since thereverse causality problem between legitimacy-building activities and company performance (Lahouel et al.,2019) exists, we need to estimate causality, not correlation. Liu et al. (2021) conduct a panel Granger
causality test to verify the reverse causality issue and find that a two-way causal relationship is confirmed

5between the degree of social contribution activities and corporate performance. Therefore, it is necessary
to address the issue of reverse causality in this study as well.
Furthermore, some studies do not avoid the problem of missing variables. An example is the country oforigin. The geographic distance between the country of origin and the country of destination is expected toaffect both firm performance Hutzschenreuter, Kleindienst, and Lange (2014) and local sourcing rates.
Nevertheless, Halaszovich and Lundan (2016) uses the variable that indicates the extent of an obstacle totransporting goods, supplies, and inputs, which can affect the company’s performance through the channelof distance from the home country. This mechanism has a strong effect on the countries of the former Soviet
republics. Compared to other countries and regions, many of the countries of the former Soviet Union arelocated inland, increasing the need for transportation by other means than just ships Therefore, thetransportation distance is correlated with the obstacles to transportation and the exclusion constraint is notsatisfied. Therefore, the reason Halaszovich and Lundan (2016) find no significant causal relationship in
the former Soviet Union countries can be explained not only by the small sample size but by missing
variable bias.
To overcome these issues, we can use an instrumental variable that is correlated with local sourcing but
is uncorrelated with other firm characteristics that affect firm performance. The instrumental variable
method has two important benefits. First, the instrumental variable method is useful to address reverse
causality issues. (ULL, 2021) Second, the instrumental variable (IV) method gives us consistent estimateseven though local sourcing is measured with error. If the instruments are also uncorrelated with themeasurement error in local sourcing that arises from the interviewee’s state rough value, then unlike OLS
estimation, IV yields consistent estimates.
We assume that the variable of bribe requests from officials is useful as an instrumental variable. The
reason is that bribe requests are an exogenous variable to the subsidiary’s decision-making and MNEs isthought to build legitimacy against bribe demands (Stevens & Newenham-Kahindi, 2021). Following theexisting studies (Halaszovich & Lundan, 2016; Joseph Li, Chen, & Yang, 2016; Oki & Kawai, 2022), we
set the following hypotheses.

Hypothesis 2: When we use bribe requests from government officials as an instrumental variable, local
sourcing has a causal effect on ROS.

6

3

Method3.1

Data and sample

To test our research hypothesis, we target companies that established subsidiaries in former Soviet Union
countries between 1993 and 2005. This context provides an ideal setting for our research questions in three
ways. First, at this age and place, a lot of MNEs entered this area. After the Soviet Union collapsed in 1991,
foreign multinationals began to take an interest in entering the market. By the mid-1990s, as the economic
situation stabilized, the former Soviet Union countries began to develop legal systems and implement
aggressive policies to attract foreign investment. As the economic situation stabilized in the mid-1990s, theformer Soviet Union countries began to develop legal systems and implement aggressive policies to attract
foreign investment. Host countries sought the management resources and network participation ofcompanies from developed countries, and companies entered through FDI in search of lower production
costs and increased demand for their products. Consequently, many MNEs have established themselves in
the region. Second, Policies toward manufacturing multinationals were similar. While there weredifferences in policies among countries in the agricultural sector, there were tiny policy differences
regarding the manufacturing industry, since all countries actively promoted the entry of manufacturers into
the manufacturing sector. It can be inferred in the case of the manufacturing industry in the former Soviet
Union, the extent of such policies was smaller than in other regions. Third, in this age and place, with thecollapse of the former Soviet government, the payment of salaries to officials began to fall behind anddemands for bribes from officials increased (Sanyal & Samanta, 2017).
We use public data from a firm-level survey conducted in countries in former Soviet republics in 2005.
Although data were collected over multiple years, we used the 2005 data because we determined that thisyear had the largest sample of MNCs and would improve the accuracy of the analysis. This data was
obtained from the world bank’s enterprise surveys which aimed at collecting data from key manufacturing
and service sectors in every region of the world. This survey uses standard survey instruments and a uniform
sampling methodology to minimize measurement error. We limited the sample to subsidiaries that had beenin operation for less than 12 years since the wide range of operation years ranging from 1 year to 320 brings
endogeneity issues. Especially, the traits of MNEs change dramatically before and after 1993. Because theformer Soviet Union countries began attracting more MNEs after 1993 (Javorcik, 2004), the nationalities

7and risk preferences of firms that entered before and after 1993 may differ significantly. After narrowing
down the data, the final sample is 231 to 384 subsidiary-level data.

3.2

Variables

All variables used are in Table 1. In equation (1), the dependent variable is local sourcing rate , which is apercentage of goods of domestic origin among inputs used in production and an instrumental variable isRequest for bribe, which is a dummy variable that takes 1 if a gift or informal request is made and otherwise
takes 0. In equation(2), the dependent variable is the return on sales(ROS), which is often used in previous
studies. (Chan, Isobe, & Makino, 2008; Li & Sun, 2017; Oki & Kawai, 2022) That is because ROS ispreferable to ROA (return on assets) as the measurement of a subsidiary’s performance in that ROS is robust
to the host country difference unrelated to the research (Chan, Isobe, & Makino, 2008).
The control variables are as follows. The subsidiary level control variables are dummy, experience, andrate of domestic market sales. Dummy takes 0 when the foreign ownership ratio is below 95% and above
5%, and 1 when the foreign ownership ratio is above 95%. The threshold value of the foreign ownership
ratio varies widely across papers. In this paper, the boundary is drawn at the point where the foreign
ownership ratio is 95%, but for robustness checks, the boundary is also drawn at 90% (Chang, Chung, &Jungbien Moon, 2013; Gaur & Lu,2007). Although some subsidiaries in the previous literature set thethreshold at 99% (Javorcik, 2004), this study uses a threshold of 95% because Laprade & Poracchia (2012)
state that in European countries except Italy, a significant shareholder is a shareholder who owns at least
5% of the company’s shares. Therefore, in this study, we use 95% as a threshold but as a robustness check,we use 90%. Experience is the value of how long the company has been in the host country. The reason foradding rate of domestic market sales is that they have a correlation with the quality of components required.
And we also controlled firm size. The industry-level control variable is Industry dummy, which controls forindustry factors such as product characteristics that cannot be fully measured by the control variables.
Finally, we add Obstacles to get license, Informal gift payment, and Corruption level of court system ascontrol variables. Country-level control variables are EU dummy, tariff rate, and GDP. The reason foradding these variables is that participation in the EU and tariff rates affect the cost of import costs, and GDP
is related to the level of technology in the local industry and affects the quality of parts from local suppliers.

8

Table 1: Variable name
Variable nameLocal sourcing rate
Predicted local sourcing
rate
ROS
Request for bribe
WOS dummy
Share of equity
Experience
Tariff rate
Firm size

Definition
Percentage of goods of domestic origin among inputs used in production
Value of local sourcing rate estimated by model1
The value of profit devided by sales
Dummy Dummy variable that takes 1 if a gift or informal request is madeA dummy variable that takes the value 0 when the foreign ownership ratio is
Dummy below 95% and above 5%, and 1 when the foreign ownership ratio is above
95%.
Percentage owned by foreign capital.
A value indicating the number of years between the firm's establishment and theLogyear in which the survey was conducted.
the weighted average of effectively applied rates for all products subject totariffs calculated for all traded goods.
Log net book value of machinery vehicles, and equipment in last fiscal year

Host country GDP

gross domestic product divided by midyear population% of national sales

percentage of sales for domestic market

EU Dummy

Dummy Dummy variable that takes 1 if the host country of the subsidiary belongs to EU.

Obstacles to get license

Obstacle to the current operations,business licensing and permits

Informal gift payment
Corruption level of court
systemThe degree of non-corruption of court% of contract value av. firm pays in informal gifts to govenment to securecontract.

4

Estimation

4.1

Bribe request and local sourcing

The dependent variable zi denotes the local sourcing rate obtained by firm i. local sourcing rate takes values
between 0 and 100. Because they are censored at the endpoints, we use the Tobit model. In this model, we
estimate the local sourcing rate after adding the instrumental variables.

zi = π0 + πibirbe + xiθ + αi + vi

9

(1)

4.2

Estimating Causal effect of local sourcing on ROS by instrumental variable method

IV method requires two important assumptions. first, there must be a sufficient correlation between IV
and local sourcing rate variable. Second, the exclusion restriction must be satisfied. The first assumption is
confirmed in Equation (1). The second issue is addressed by a robustness check by adding the control
variable.
The estimating equation for the first step is the same as Equation (1). And to test Hypothesis 2, we use
Predicted local sourcing rate as a second-stage explanation variable. In the second model, I estimated thecausal effect of local sourcing on the company’s performance.
(2)

5

ResultTable 2 provides descriptive statistics of our sample. Table 3 reports the correlation matrix for the variable.
We start our analysis by estimating a Tobit regression of the choice of local sourcing. Table 4 reports theresults with positive and significant (p<0.01) indicating that MNEs choose high local sourcing rates when
they are asked to pay the bribe. In Column (1) the threshold between Wholly owned subsidiaries (WOs)and Joint venture subsidiaries (JVs) are 90% and in Column (2) the threshold is 95%.

10

Table 2: Basic statistics

11

0.0013-0.04160.0029-0.0487-0.0819-0.08840.01560.11190.15530.00660.00410.03220.0353-0.0133
0.0351

WOS dummy

Share of equity

Experience

Tariff rate

Firm size

Host country GDP% of national sales

EU Dummy
Obstacles to getlicenseInformal gift payment
Corruption level ofcourt system112-0.0341-0.0057

0.18340.00640.0675-0.025-0.013-0.0723

0.1247

Request for bribe

1
0.0497

ROS

ROS

Local sourcing rate

Local
sourcing
rate

1-0.0875

0.2336

0.1083-0.13310.107-0.1828

0.008

0.15480.022-0.0721-0.025

Requestfor bribe

10.0157-0.0402-0.1083-0.0007

0.00790.12180.0176

-0.15

0.034

0.9007

WOS
dummy

1

0.0303-0.019-0.0868

0.01950.00620.15160.0215-0.1491

0.008

Share ofequity0.0064-0.00170.0117-0.02930.1209-0.0368

0.0224-0.05681-0.1184

0.0579-0.0016-0.3373

0.1238-0.39930.07391

0.1539-0.13210.04930.0288-0.3092-0.11531
10.0931-0.0461-0.0408

0.2737-0.0514

Host
Experienc
Tariff rate Firm size country
e
GDP

1

-0.0333

0.0813-0.0654-0.086% ofnational
sales

10.1208-0.1282

0.0552EU
Dummy-0.04930.20931
1-0.1047

Obstacles Informal
to getgift
licensepayment

1

Corruption
level of court
systemTable 3: Correlation matrix

Table 4: Tobit estimate

Also, this strong relationship with Request for bribe and local sourcing rate imply that Request for bribeis useful for meeting the relevance assumption of the IV method. Of the control variables, Tariff rate has apositive and significant(p<0.05) correlation with Local sourcing rate, implying that when tariffs are high,the cost of importing materials increases, so materials are procured domestically. The Host country GDP ispositive and significant (p<0.05) implying that materials from economically developed countries are ofhigh quality and readily available to MNEs. The EU dummy is positive and significant (p<0.05), which isbeyond our expectations. It’s possible to explain that accession to the EU has made it easier to procure
locally, as many MNEs have moved in from Western countries.

13

The result of hypothesis 2 is in Table 5. In columns (1) and (2), the coefficient of Predicted local sourcing
rate is positive and significant (p<0.01), indicating that local sourcing has a positive causal effect on ROS.
Since this study follows the definition by Laprade & Poracchia (2012), we use 95% threshold point since
this model. In column (2) of Table 5, there is no control variable below p<0.05 significance.

Table5: Second stage estimation

14

5.1

Robustness check

As a robustness check, we confirm the exclusion restriction of IV by adding three control variables. First,
the existence of a bribe demand can change the operation cost. When a bribe demand is made and companies
accept the demand, a bribe payment occurs. The payment of a bribe may reduce a firm’s investment inproduction equipment, etc., and thus reduce its profit per employee. Therefore, we include Informal gift
payment as a control variable. Second, it is also conceivable that the government office would speed up its
administrative procedures in return for paying a bribe. Salmi and Heikkil¨a (2015) indicate thatMultinational companies are connected through various channels not only to the officials in charge ofinspections but also to the officials in charge of licensing. Therefore, factors such as more demands forbribes may be correlated with connections to the licensing officials and may affect the time it takes for acompany to obtain approval for a license. Therefore, we included obstacles to obtaining a license as a newcontrol variable. Moreover, the degree of corruption in the society to which the MNEs belongs has morevariations than at the national level. Corruption levels on a local basis may affect bribe demands andcorporate performance. Therefore, we used the subsidiary-level control variable corruption level of court
system as the degree of local-level corruption. The result is in the supplemental Table 6. This result showsthat the coefficient of the Predicted local souring rate is positive and significant (p<0.05). Though thesignificance level has decreased from p<0.01 to p<0.05, this can be explained by the decrease in sample
size. And when it comes to control variables, no coefficient is significant at 0.05% point, which imply thatbribe request from government officials meets the assumption of exclusion restriction.

15

Table 6: Robustness check6

Discussion and conclusion

To understand MNE ’s legitimacy-building activity against bribe requests and its causal effect on ROS, we
use MNE’s subsidiary-level data in the former Soviet Union republics and find two important things. First,
we find that MNEs enhance local sourcing rates when they receive bribe demands from local government
officials. This implies that when MNEs receive unofficial requests from the government, they choose a way

16

that will not undermine the legitimacy of their home countries and deflect pressure from host countries.
Second, this study shows the validity of bribe requests from government officials as an instrumental variable
to understand the causal effect of local sourcing on a subsidiary’s performance. While existing studies haveclarified the relationship between local sourcing and performance, they often face problems in analyzing thecausal effect. This study estimates the causal effect between them by using bribe requests from government
officials as an instrumental variable and confirms a positive causal effect between them.
This paper has two contributions. The first is for the international business literature. While somequalitative research finds that MNEs build legitimacy using means unrelated to paying bribes, no qualitative
study analyzes this phenomenon. Our study analyzes the relationship between bribe requests andlegitimacy-building activities. And the results show the external validity of a recent qualitative study(Stevens & Newenham-Kahindi, 2021). The second is about the analysis method. We show that the
instrumental variable is a useful way to analyze the relationship between local sourcing and performance.
When we perform multiple regression analysis, Figure 1 is obtained, while when the instrumental variable
method was used, Figure 2 is obtained. By making causal inferences explicitly in this way, we show that
we can obtain these accurate results.

Figure 1: Scatterplot before using IV method

Note: A comparison of local sourcing rates and profit per employee before using the instrumental variable.

17Figure 2: Scatterplot after using IV method

Note: A comparison of local sourcing rates and profit per employee after using the Instrumental variable.

6.1

Limitation and Future ResearchThis paper has several limitations. First, the data on the bribe request and local sourcing were obtained at
the same time. In accordance with prior research (Elg et al., 2017; Salmi & Heikkil¨a, 2015; Stevens &Newenham-Kahindi, 2021), we know bribes affect legitimacy-building behavior, but we have notcompletely ruled out the possibility of reverse causality. Therefore, further analysis, such as panel data
analysis is needed.
Also, this paper does not analyze boundary conditions. However, the relationship between unofficial
pressure from local government and legitimacy-building activity, and the causal effect of local sourcing
may vary depending on the boundary conditions. For example, when it comes to the relationship between
local sourcing and performance, an existing study shows the importance of boundary conditions (Oki &Kawai, 2022). Therefore, future research should be conducted to find a moderator for each of them. In thiscase, it would be advantageous to use bribe requests from the local government as an instrumental variable.

Acknowledgement
We thank the Enterprise Analysis Unit of the Development Economics Global Indicators Department of
the World Bank Group for making the data available. This work was supported by JSPS KAKENHI Grant
Number 20H01526.

18

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